Microeconomic Theory Andreu Mas-Colell Michael D. Whinston and. Jerry R. Green New York Oxford OXFORD UNIVERSITY PRESS — 1995OXFORD UNIVERSITY PRESS Oxford New York Aten Acland Manghak —Bomboy CCalewtu Cage Town Dares Sasun "Del Tvence Hoag Kong. (nbal Kah Koala Hamper Madr Made Melboune Mesica City Naim Pci Segue Tape thy a akscuted compares in Bern Po Copyright © 1995 by Oxford University Press, Inc Puts by Cnfued Cnisersty res. Ine 1 Mason Avenue, New York, New York KANG (Oxi i epstonsd trademark of Onford Univenity ess Alight tesers Nop of his poblicaton may be reprenuce ‘tore in retrieval ays ese, by my form By any means ‘Slevtni, medhanical, photocopying, eecaning, ohete, Without he pre pemmianion uf Oxford Uaivensity Press Lateary of Congens Catakgngs MacColl, Aires ‘Micoteusi they? Anew Mas-Coe, Mitac. Whinson, and Jey R Gees pam Inetates tngapnical references at en ISDN 0:19.597380-1 (clot ISBN 0-19. 510268 1 paper Microccanonies. L Whsston, Miso! Deon IL Gren, ery RI. Tite MBLTZMEDH? 1998 PES 42005-8128 Abction Dats Pritd ie the Une Sts of Ameticn lense papeContents Preface Xili PART ONE: INDIVIDUAL DECISION MAKING 3 Chapter 1, Preference and Choice 5 L.A Introduction 5 1.B Preference Relations 6 1.C Choice Rules 9 1.D The Relationship between Preference Relations and Choice Rules 11 Exercises 1S Chapter 2, Consumer Choice 17 2.A Introduction 17 2.B Commoditics 17 2.C The Consumption Set 18 2.D Competitive Budgets 20 2 Demand Functions and Comparative Statics 23 The Weak Axiom of Revealed Preference and the Law of Demand 28 2F Exercises 36 Chapter 3. Classical Demand Theory 40 3.A Introduction 40 3.B_ Preference Relations: Basic Properties 41 3.C Preference and Utility 46 3.D The Utility Maximization Problem 50 3.E The Expenditure Minimization Problem 57 3.F Duality: A Mathematical Introduction 63 3.G_ Relationships between Demand, Indirect Utility, and Expenditure Functions 67 3.H_ Integrability 75 3.1 Welfare Evaluation of Economic Changes 80 3.J. The Strong Axiom of Revealed Preference 91 Appendix A: Continuity and Differentiability Properties of Walrasian Demand 92 Exercises 96 Chapter 4. Aggregate Demand 105 4.A Introduction 105 4.B Agyregate Demand and Aggregate Wealth 106viii CONTENTS 4.C Aggregate Demand and the Weak Axiom 109 4.D Aggregate Demand and the Existence of a Representative Consumer 116 Appendix A: Regularizing Effects of Aggregation 122 Exercises. 123 Chapter 5. Production 127 5.A Introduction 127 5.B Production Sets 128 5.C Profit Maximization and Cost Minimization 135 5.D The Geometry of Cost and Supply in the Single-Output Case 143 5.E Aggregation 147 5.F Efficient Production 149 5.G Remarks on the Objectives of the Firm 152 Appendix A: The Linear Activity Model 154 Exercises 160 Chapter 6, Choice Under Uncertainty 167 6.A Introduction 167 6B Expected Utility Theory 168 6.C Money Lotteries and Risk Aversion 183 6.D Comparison of Payoff Distributions in Terms of Return and Risk 194 6.E State-dependent Utility 199 6.F Subjective Probability Theory 205 Exercises 208 PART TWO: GAME THEORY 217 Chapter 7. Basic Elements of Noncooperative Games 219 7.A Introduction 219 7.B What Isa Game? — 219 7.C The Extensive Form Representation of aGame 221 7.D Strategies and the Normal Form Representation of a Game 228 7.E Randomized Choices 231 Exercises 233 Chapter 8. Simultaneous-Move Games 235 8.A Introduction 235 8.B Dominant and Dominated Strategies 236 8.C_ Rationalizable Strategies 242 8.D Nash Equilibrium 246 8.E Games of Incomplete Information: Bayesian Nash Equilibrium 253 8.F The Possibility of Mistakes: Trembling-Hand Perfection 258 Appendix A: Existence of Nash Equilibrium 260 Exercises 262Chapter 9. Dynamic Games 267 9.A Introduction 267 9.B Sequential Rationality, Backward Induction, and Subgame Perfection 9.C Beliefs and Sequential Rationality 282 9.D_ Reasonable Beliefs and Forward Induction 292 Appendix A: Finite and Infinite Horizon Bilateral Bargaining 296 Appendix B: Extensive Form Trembling-Hand Perfect Nash Equilibrium 299 Exercises 301 268 PART THREE: MARKET EQUILIBRIUM AND MARKET FAILURE Chapter 10, Competitive Markets 311 10.4 Introduction 311 10.B Pareto Optimality and Competitive Equilibria 312 10.C_ Partial Equilibrium Competitive Analysis 316 10.D The Fundamental Welfare Theorems in a Partial Equilibrium Context 10.E Welfare Analysis in the Partial Equilibrium Model 328 10.F — Free-Entry and Long-Run Competitive Equilibria 334 10.G_ Concluding Remarks on Partial Equilibrium Analysis 341 Exercises 344 307 325 Chapter 11. Externalities and Public Goods 350 ILA Introduction 350 11.B A Simple Bilateral Externality 351 ILC Public Goods 359 11.D Multilateral Externalities 364 I.E Private Information and Second-Best Solutions 368 Appendix A: Nonconvexities and the Theory of Externalities 374 Exercises. 378 Chapter 12. Market Power 383 12.4 Introduction 383 12.B Monopoly Pricing 384 12.C Static Models of Oligopoly 387 12.D Repeated Interaction 400 Entry 405 The Competitive Limit 411 Strategic Precommitments to Affect Future Competition 414 Appendix A: Infinitely Repeated Games and the Folk Theorem 417 Appendix B: Strategic Entry Deterrence and Accommodation 423 Exercises 428x CONTENTS Chapter 13. Adverse Selection, Signaling, and Screening 436 13.A Introduction 436 13.B Informational Asymmetrics and Adverse Selection 437 13.C Signaling 450 13.D Sereening 460 Appendix A: Reasonable-Belicfs Refinements in Signaling Games 467 Exercises 473 Chapter 14. The Principal-Agent Problem 477 14.A — Introduction 477 14.B Hidden Actions (Moral Hazard) 478 14.C Hidden Information (and Monopolistic Screening) 488 14.) Hidden Actions and Hidden Information: Hybrid Models 501 Appendix A: Multiple Effort Levels in the Hidden Action Model 502 Appendix B: A Formal Solution of the Principal-Agent Problem with Hidden Information Exercises 507 PART FOUR: GENERAL EQUILIBRIUM Stl Chapter 15. General Equilibrium Theory: Some Examples 515 15.A Introduction — 515 15.B Pure Exchange: The Edgeworth Box 515 15.C The One-Consumer, One-Producer Economy 525 15.D The 2 x 2 Production Model 529 15.F General Versus Partial Equilibrium Theory 538 Exercises, 540 Chapter 16. Equilibrium and Its Basic Welfare Properties 545 16.A Introduction 545 16.B The Basic Model and Definitions 546 16.C The First Fundamental Theorem of Welfare Economics 549 16.D The Second Fundamental Theorem of Welfare Economics S51 16.E Pareto Optimality and Social Welfare Optima 558 16.F First-Order Conditions for Pareto Optimality 561 16.G Some Applications 566 Appendix A: Technical Properties of the Set of Feasible Allocations 573 Exercises 575 Chapter 17. The Positive Theory of Equilibrium 578 17.A Introduction 578 17.B Equilibrium: Definitions and Basic Equations 579 17.C Existence of Walrasian Equilibrium 58417.D I7.E 17.F 17.G 17.H 17.1 Appendix A: Characterizing Equilibrium through Welfare Equations 630 Appendix B: A General Approach to the Existence of Walrasian Equilibrium 632 Exercises. 641 Local Uniqueness and the Index Theorem 589 Anything Goes: The Sonnenschein-Mantel—-Debreu Theorem 598 Uniqueness of Equilibria 606 Comparative Statics Analysis 616 Tatonnement Stability 620 Large Economies and Nonconvexities 627 Chapter 18. Some Foundations for Competitive Equilibria 652 18.A 18.B 18.C 18.D 18.E Appendix A: Cooperative Game Theory 673 Exercises 684 Introduction 652 Core and Equilibria 652 Noncooperative Foundations of Walrasian Equilibria 660 The Limits to Redistribution 665 Equilibrium and the Marginal Productivity Principle 670 Chapter 19. General Equilibrium Under Uncertainty 687 19.A 19.B 19.C 19.D 19.E 19.F 19.G 19.H Introduction 687 A Market Economy with Contingent Commodities: Description 688 Arrow Debreu Equilibrium 691 Sequential Trade 694 Asset Markets 699 Incomplete Markets 709 Firm Behavior in General Equilibrium Models Under Uncertainty 713 Imperfect Information 716 Exercises 725 Chapter 20. Equilibrium and Time 732 20.4 20.B 20.C 20.D 20.E 20.F 20.G 20.H 20.1 Introduction 732 Intertemporal Utility 733 Intertemporal Production and Efficiency 736 Equilibrium: The One-Consumer Case 743 Stationary Paths, Interest Rates, and Golden Rules 754 Dynamics 759 Equilibrium: Several Consumers 765 Overlapping Generations 769 Remarks on Nonequilibrium Dynamics: Tatonnement and Learning 778 Exercises 782 CONTENTS xi